December 28, 2003

Notes: Thoughts on ENRON

ENRON seems to have consisted of a guy (Kenneth Lay) who believed that deregulation would produce huge profit opportunities (but weren't sure what they were), a guy (Jeff Skilling) who understood that deregulation would produce huge profit opportunities to a firm that could become the best at trading natural-gas contracts in newly-deregulated energy markets (but had no clue what to do next--other than to piss away billions upon billions of $$$$$ trying to enter markets that nobody inside ENRON understood), a guy (Andrew Fastow) whom Lay and Skilling let steal $100 million because he was very good at both legal and illegal large-scale financial fraud, a host of investors and analysts who paid no attention to the large wedges between ENRON's unimpressive cash-flow and its impressive reported earnings, and a host of other enablers.

I had thought that ENRON's problem was that it started by trying to hide losses for one quarter until the business got a good bounce, played double-or-nothing in this business for a couple of years, and wound up in real trouble as a result. But it looks considerably worse than that. It looks like a game of "let's see how long we can fool the shareholders" from the very start of the Lay-Skilling era.

Bethany McLean and Peter Elkind (2003), The Smartest Guys in the Room: The Amazing Rise and Fall of ENRON (New York: Penguin: 1591840082).

Posted by DeLong at December 28, 2003 02:16 PM | TrackBack

Comments

A lot of people (including me) originally thought the issue was limited to hiding debt ala the SPEs. But then our financial press starting digging as well as writing some excellent articles on this complex scandal. The only silver lining to this scandal is that we had some very good writers at the WSJ, NYTimes, etc. whose investigations have taught at least me a lot - even if I still am baffled at what Fastow was able to pull off unfortunately.

Posted by: Harold McClure on December 28, 2003 02:37 PM

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From knowledge@wharton:

http://knowledge.wharton.upenn.edu/index.cfm?fa=viewArticle&id=911

Why Smart People Do Unethical Things: What's Behind Another Year of Corporate Scandals.

Excerpt:

"For a man like Dick Strong to market-time his own fund (for an alleged gain of $600,000), where is the rationale in that? He's worth $800 million. But I guess some people become so competitive they've got to win every single day."

I have an explanation for that: Either (a)Dick Strong had become a very confused man or (b)something is wrong about American corporate culture and something better should replace it -- and will replace it.

OSS people appear to have a very different cultural make up than the likes of Dick Strong.

Posted by: Bulent Sayin on December 28, 2003 02:40 PM

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I know this posting will be going in a different direction than most Enron discussions, but Enron at its core was an energy company gas lines. And unfortunately, energy in general and gas in particular are extremely important subjects that are not being given much serious discussion these days by the media, but Bush administration, or even the DOE. So I would like to take this opportunity to point out some extremely important facts that only a handful of scientists currently appreciate, but economists need to begin taking seriously.

We are running out of oil and gas much faster that was generally assumed just three years ago. Colin Campbell especially deserves the credit for tirelessly sorting out the good, the bad, and the redundant data in the area of unproven oil reserves. Over the past year, his oil depletion model has increasingly gained acceptance as the gold standard except of course in the U.S., where the DOE and the EIA stand alone against the world in their groundless beliefs that the amount of readily available "regular oil" remaining to be pumped is about twice the one trillion barrels the Campbell model predicts. At the current rate of global oil production, it will all be gone in 35 years. Of course, that's not the way it will happen. Rather, we have the well-known Hubbert curve. And in case you didn't notice, world oil production peaked in 2000. After a very strong global economic recovery for the past year, oil production is back to that level and will probably increase for a few more years before beginning its inexorable decline.

With the price of oil now up more than 50% in the past two years, driven largely by unexpectedly rapid growth in China along with the physical inability of the OPEC countries to increase production, the price of oil seems likely to hit the $50/bbl level (current dollars) within 5-10 years. At that point, liquid biofuels will take off with a vengeance. Ethanol from corn and biodiesel from soy or rape seed will play increasingly lesser roles as more efficient feedstocks and processes are developed. Switchgrass produces 11 tons of biomass per acre per year, which can be used to produce 1100 gallons of cellulosic ethanol or 2000 gallons of methanol, and the methanol can be dehydrated to ethylene for the production of bio-gasoline and biodiesel. Recent research suggests the potential from high-oil algae is more than an order of magnitude greater yet per acre.

Replacing liquid fossil fuels with biofuels will be the first major step in the complete transition to renewables, and it will begin being forced upon us by petroleum resource limitations within a decade. However, the transition from petroleum to liquid biofuels will be even more disruptive to modern civilization than global warming during the next several decades if we don't begin to take serious steps very soon. And in case you're under some illusion that hydrogen is in some way going to help, check out the in-depth discussions under the Energy Forum at http://deanissuesforum.com/ .

Perhaps the relevance of the above points to the Enron case is that the major upheavals in oil and gas coming in the next decade will provide ample opportunity for more cases of energy market manipulation. But the bigger problem goes beyond market manipulation and fraud. If we aren't prepared when the oil and gas lines begin to dry up, the next oil crisis will make the previous ones look like a walk in the park.

References:

1. C. J. Campbell and Anders Sivertsson, "Updating The Depletion Model", ASPO Meeting, Paris, 2003. See also, http://www.peakoil.net/.
2. George Olah, "The Methanol Economy", C&E News, September 22, 2003. See also,
http://www.usc.edu/assets/college/faculty/profiles/60.html.
3. L. B. Lave, W. M. Griffin, and H. MacLean, "The Ethanol Answer to Carbon Emissions", Issues in Sci. and Tech., Winter, 2001. http://www.nap.edu/issues/18.2/lave.html.
4. Michael Briggs, http://www.unh.edu/p2/biodiesel/article_alge.html

Posted by: F. David Doty, PhD on December 28, 2003 05:26 PM

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F. David Doty:"We are running out of oil and gas much faster that was generally assumed just three years ago"

F, why would we wait to transition to expensive biofuels at $50/barrel when cheaper technologies already exist? Canada has enormous amounts of oil sands which are currently being converted at under $15/barrel. The US and China have enormous amounts of coal which can be turned into clean diesel at about $30/barrel. (And they are now even testing processes such as turkey carcass to diesel.) Coal and oil sands might not be renewable, but it will be enough to hold off the scenario you describe until energy from solar and hydrogen technologies is inexpensive.

"With the price of oil now up more than 50% in the past two years, driven largely by unexpectedly rapid growth in China along with the physical inability of the OPEC countries to increase production"

Don't forget the decline of the dollar. Previously, a high dollar made oil appear to be cheap in the US, but not elsewhere. And considering how other countries tax petroleum, $50/barrel is not really all that much to pay. It will be more of a reason to build hybrid diesel vehicles more than it would be a crisis requiring a switch to renewables. Also, let's not forget how fast OPEC will start pumping once we demonstrate our alternative options.

Posted by: snsterling on December 29, 2003 05:53 AM

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